What Does Avarga Limited's (SGX:U09) Balance Sheet Tell Us About It?

Simply Wall St

Tue, Jul 9, 2019, 11:38 PM

Investors are always looking for growth in small-cap stocks like Avarga Limited (SGX:U09), with a market cap of S$180m. However, an important fact which most ignore is: how financially healthy is the business? Evaluating financial health as part of your investment thesis is vital, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. We'll look at some basic checks that can form a snapshot the company’s financial strength. However, potential investors would need to take a closer look, and I’d encourage you to dig deeper yourself into U09 here.

Does U09 Produce Much Cash Relative To Its Debt?

U09's debt levels surged from S$179m to S$274m over the last 12 months – this includes long-term debt. With this increase in debt, U09 currently has S$26m remaining in cash and short-term investments to keep the business going. On top of this, U09 has generated S$70m in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of 26%, signalling that U09’s debt is appropriately covered by operating cash.

Can U09 pay its short-term liabilities?

At the current liabilities level of S$214m, it appears that the company has been able to meet these commitments with a current assets level of S$375m, leading to a 1.75x current account ratio. The current ratio is calculated by dividing current assets by current liabilities. Generally, for Forestry companies, this is a reasonable ratio since there's a sufficient cash cushion without leaving too much capital idle or in low-earning investments.

Does U09 face the risk of succumbing to its debt-load?

With debt reaching 59% of equity, U09 may be thought of as relatively highly levered. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. No matter how high the company’s debt, if it can easily cover the interest payments, it’s considered to be efficient with its use of excess leverage. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In U09's case, the ratio of 4.63x suggests that interest is appropriately covered, which means that lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.

Next Steps:

Although U09’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet obligations which means its debt is being efficiently utilised. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. This is only a rough assessment of financial health, and I'm sure U09 has company-specific issues impacting its capital structure decisions. I recommend you continue to research Avarga to get a more holistic view of the small-cap by looking at: